Question

The focus of the last discussion assignment was Boeing Inc. and how some of the company's financial ratios may be affected by the 737 MAX disasters. Now direct the discussion to the company's stock valuation and how it is being affected. In your discussion (in one or two paragraphs) include how the events affect each of the three variables in general stock valuation models: Dividends, growth of the dividends and earnings, and the required return on the stock.

For reference, this was the last discussion prompt:

The Boeing Company is under heavy investigation into the disastrous 737 Max events. The company is part of the Aerospace and Defense Industry.

Currently it appears that some key financial ratios are very close to industry norms or averages.

Current Ratio 1.03 times; Return on Assets 2.69%; Long-term Debt Ratio 17%.

As learned in Ch 3, Return on Assets (ROA) reflects both profit margin and the company's operational efficiency.

Answer 1

Solution:

In the given question, we have been asked to analyze the affect of 737 MAX Disasters on overall company's stock valuation and the variables used in general stock valuation model, i.e. Dividends, Growth of Dividends & Earnings and Required return on the Stock.

Affect on Required Return on Stock:

Now, as the Boeing Company is under heavy investigation in disastrous 737 Max Events, hence trust of investors or share holders will decrease till results of investigation are declared. Because of decreased trust, investors will require more risk premium on their investments. Hence, Required Return on Stock will Increase.

Affect on Growth of Dividends & Earnings:

As Required return on stock by investors increase, hence cost of capital will increase for the company. Because of increased cost of capital, profit margin of company will decrease. Hence, earnings of company will decrease.

Next year Estimated Dividend is given by formula:

Now, because of investigation, company's earnings will decrease. Hence, company will not able to invest in new projects, research & development at same prevailing rate. Hence, expected growth rate will decrease. Therefore, from above formula, Growth of Dividends will decrease.

Affect on Dividends:

Next year Estimated Dividend is given by formula:

Further, as discussed above, company's earnings will also decrease. Hence, company may not give same amount of dividend which it is giving now.

Affect on Company's Stock Valuation:

Price per share is given by formula:

Now as discussed above, Cost of Capital will Increase and Expected Growth Rate will decrease. Hence, Denominator of above expression will Increase. Further, because of decreasing expected growth rate, numerator of above formula will decrease.

Hence, Price per share of company is expected to be decreased.